Choice of English law presides in ISDA Master Agreements

A recent High Court decision has held that the law applicable to swaps entered into by a Portuguese bank and several Portuguese transport companies would be English law – as the law chosen by the parties in the ISDA Master Agreement governing those transactions.

The judgement in Banco Santander Totta S.A. v Companhia de Carris de Ferro de Lisbao S.A. and others [2016] EWHC 465 (Comm) has far reaching implications because the issue raised in this case was whether the application of English law to the issues in dispute (being the validity of the swaps) could be overcome by the application of article 3(3) of the Rome Convention on the law applicable to contractual obligations, which provides that:

“3. The fact that the parties have chosen a foreign law, whether or not accompanied by the choice of a foreign tribunal, shall not, where all the other elements relevant to the situation at the time of the choice are connected with one country only, prejudice the application of rules of the law of that country which cannot be derogated from by contract, hereinafter called ‘mandatory rules’”.

The Rome Convention is applicable to all contracts made between 1 April 1991 and 17 December 2009. The Rome Convention was replaced the Rome I Regulation which applies to contracts made after 17 December 2009. The Rome I Regulation contains a similar (but not identical) provision to that in Article 3(3) of the Rome Convention. As such, the judgment in Banco Santander, will have some relevance for contracts made after 17 December 2009.

This was also the first case to be heard in the new Financial List in the High Court. The Financial List is a specialist list set up to handle claims related to the financial markets. The Financial List is aimed at cases which would benefit from being heard by judges with particular expertise in the financial markets or which raise issues of general importance to the financial markets so that they are dealt with by judges with suitable expertise and experience.

The facts

The case concerned nine interest rate swaps which were entered into by Banco Santander Totta (“BSTTransport Companies”) and several Portuguese transport companies operating the metro, bus and tram services in Lisbon and Porto, Portugal (the “”). The swaps included a memory feature which meant that each fixed rate of interest for the swaps was calculated and then added to the previous rate, thereby resulting in very high cumulative fixed rates of interest. Each of the swaps was governed by English law and subject to an ISDA Master Agreement.

The Transport Companies asserted in their defence that Article 3(3) of the Rome Convention applied, thereby allowing the Transport Companies to rely on Portuguese mandatory rules. If successful, the Portuguese mandatory rules relating to an ‘abnormal change of circumstances’ and ‘games of chance’ would provide the Transport Companies with a defence to seek to avoid the implications of the financial cost which they faced.

Application of Article 3(3) in the context of Derivatives Claims

In Banco Santander, Blair J considered the decision in Dexia Crediop SpA v Commune di Prato [2015] EWHC 1746 (Comm), which concerned an Italian bank that had entered into a series of swap agreements with an Italian local authority. In Dexia, two elements were identified which were not connected with Italy, first, that the master agreement was in the standard ISDA form; and secondly, that for each of the swaps, the Italian bank had entered into back-to-back hedging swaps with a bank outside Italy in the international market. Notwithstanding those international elements in Dexia, it was held that Article 3(3) did apply to the swaps agreements.

In contrast, Blair J in Banco Santander held that Article 3(3) did not apply to the nine swaps agreements because the swaps had an international element to them and it could not be said that all elements related to the swaps were connected with Portugal only. The following five international elements were identified in relation to these swaps:

1. the right to assign BST’s rights to a bank outside Portugal;
2. the use of standard international documentation (e.g. Multicurrency-Cross Border form of the 1992 ISDA Master Agreement);
3. the practical necessity for the relationship with a bank outside Portugal;
4. the international nature of the swaps market in which the contracts were concluded; and
5. the fact that back-to-back contracts were concluded with a bank outside Portugal in circumstances in which hedging arrangements were routine.

Blair J held that the enquiry required under Article 3(3) should not be limited to elements that are local to another country, but to the ‘situation’ that included elements that point directly from a purely domestic to an international situation. In conducting such an enquiry, the use of ISDA or other standard documentation used internationally, and the fact that the transactions are part of a back-to-back chain involving other countries, may also be relevant.

Conclusion

Interest rates swaps usually contain an international element, whether this is as a result of the multinational nature of the bank involved, e.g. Banco Santander Totta, or the use of the ISDA Master Agreement itself. Whilst there is a Local Currency—Single Jurisdiction form of the 1992 ISDA Master Agreement, in our experience it is rarely used in the market now and the default form of the 1992 ISDA Master Agreement in use is the Multicurrency-Cross Border form. The 2002 ISDA Master Agreement provides for no such distinction with only one form in use, being the Multicurrency-Cross Border one.

Applying Blair J’s reasoning, it is difficult to envisage scenarios in which the conditions under Article 3(3) will be satisfied in the context of such transactions entered into pursuant to the Multicurrency-Cross Border form of the 1992 ISDA Master Agreement and the 2002 ISDA Master Agreement. This will provide comfort for international banks operating under these ISDA Master Agreements even where the Master Agreement is in place with a bank’s ‘local’ customers.